The relationship between financial leverage and profitability Pelican Paper, Inc., and Timberland Forest, Inc., are rivals in the manufacture of craft papers. Some financial statement values for each company follow .

Item Pelican Paper, Inc. Timberland Forest, Inc.
Total assets $10,900,000 $10,900,000
Total equity (all common) 9900000 5400000
Total debt 1000000 5500000
Annual interest 100000 550000
Total sales 23000000 23000000
EBIT 5750000 5750000
Earnings available for
common stockholders 3394800 3174000
Use them in a ratio analysis that compares the firms' financial leverage and profitability

. The debt ratio for Pelican is

%.

(Round to one decimal place.)

The debt ratio for Timberland is

%.

(Round to one decimal place.)

The times interest earned ratio for Pelican is

.

(Round to one decimal place.)

The times interest earned ratio for Timberland is

.

(Round to one decimal place.)

Discuss their financial risk and ability to cover the costs in relation to each other. (Select all the answers that apply.)

A.

Pelican has a much higher degree of financial leverage than does Timberland. As a result, Pelican's earnings will be morevolatile, causing the common stock owners to face greater risk.

Your answer is not correct.

B.

Pelican's earnings will be more volatile. This additional risk is supported by the significantly lower times interest earned ratio of Pelican. Timberland can face a very large reduction in net income and still be able to cover its interest expense.

C.

Timberland's earnings will be more volatile. This additional risk is supported by the significantly lower times interest earned ratio of Timberland. Pelican can face a very large reduction in net income and still be able to cover its interest expense.

.

D.

Timberland has a much higher degree of financial leverage than does Pelican. As a result, Timberland's earnings will be morevolatile, causing the common stock owners to face greater risk.

This is the correct answer.

b. The operating profit margin for Pelican is

%.

(Round to one decimal place.)

The operating profit margin for Timberland is

%.

(Round to one decimal place.)

The net profit margin for Pelican is

%.

(Round to two decimal places.)

The net profit margin for Timberland is

%.

(Round to two decimal places)

The return on total assets for Pelican is

%.

(Round to one decimal place.)

The return on total assets for Timberland is

%.

(Round to one decimal place.)

The return on common equity for Pelican is

%.

(Round to one decimal place.)

The return on common equity for Timberland is

%.

(Round to one decimal place.)

Discuss their profitability relative to each other. (Select all the answers that apply.)

A.

Timberland is more profitable than Pelican as shown by the higher net profit margin and return on assets.

B.

The return on equity for Pelican is higher than that of Timberland.

C.

Pelican is more profitable than Timberland as shown by the higher net profit margin and return on assets.

D.

The return on equity for Timberland is higher than that of Pelican.

This is the correct answer.

c. In what way has the larger debt of Timberland Forest made it more profitable than Pelican Paper? What are the risks thatTimberland's investors undertake when they choose to purchase its stock instead of Pelican's? (Select the best answer below.)

A.

Since Timberland has a higher relative amount of debt, thestockholders' equity is proportionally reduced resulting in the higher return on equity than that obtained by Pelican. The higher ROE brings with it higher levels of financial risk for Timberland equity holders.

.

B.

Even though Pelican is more profitable (higher net profitmargin), Timberland has a higher ROE than Pelican due to the additional financial leverage risk.

C.

The lower profits of Timberland are due to the fact that interest expense is deducted from EBIT. Timberland has

$480,000

of interest expense to Pelican's

$130,000.

Even after the tax shield from the interest tax deductionTimberland's profits are less than Pelican's by

$249,600.

D.

All of the above